"Size-biased risk measures of compound sums"

Denuit, Michel

ABSTRACT

The size-biased, or length-biased transform is known to be particularly useful in insurance risk

measurement. The case of continuous losses has been extensively considered in the actuarial literature.
Given their importance in insurance studies, this paper concentrates on compound sums. The zero-
augmented distributions which naturally appear in the individual model of risk theory are obtained as
particular cases when the claim frequency distribution is concentrated on {0,1}. The general results derived
in this paper help actuaries to understand how risk measurement proceeds since the formulas make
explicit the loadings corresponding to each source of randomness. Some simple and explicit expressions
are obtained when losses are modeled by compound Poisson sums and compound mixed Poisson
sums, including the compound Negative Binomial sums. Extensions to conditionally independent risks are
discussed. As an illustration, the paper considers the case of compound mixed Poisson sums where t...

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SIZE-BIASED RISK MEASURES OF
COMPOUND SUMS

M. Denuit

DISCUSSION PAPER | 2019 / 09

SIZE-BIASED RISK MEASURES OF COMPOUND
SUMS

MICHEL DENUIT
Institut de statistique, biostatistique et sciences actuarielles - ISBA
UCLouvain
B-1348 Louvain-la-Neuve, Belgium
michel.denuit@uclouvain.be
 Abstract

The size-biased, or length-biased transform is known to be particularly useful in insurance

risk measurement. The case of continuous losses has been extensively considered in the ac-
tuarial literature. Given their importance in insurance studies, this paper concentrates on
compound sums. The zero-augmented distributions which naturally appear in the individual
model of risk theory are obtained as particular cases when the claim frequency distribution is
concentrated on {0, 1}. The general results derived in this paper help actuaries to understand
how risk measurement proceeds since the formulas make explicit the loadings corresponding
to each source of randomness. Some simple and explicit expressions are obtained when losses
are modeled by compound Poisson sums and compound mixed Poisson sums, including the
compound Negative Binomial sums. Extensions to conditionally independent risks are dis-
cussed. As an illustration, the paper considers the case of compound mixed Poisson sums
where the Poisson means are proportional to a random common risk factor.

Keywords: Weighted risk measures, Conditional tail expectation, Panjer recursion, Com-
pound Poisson distribution, Compound mixed Poisson distribution, Infinite divisibility, Com-
mon mixture model.
1 Introduction and motivation
Several transforms have been widely used in the actuarial literature. Let us mention the
Esscher transform and the stationary-excess operator, for instance. The Esscher transform
(or exponential tilting) reduces the probabilities of small values in favor of probabilities
of large values and plays an important role in theoretical considerations about premium
calculation and risk measurement (see e.g. Chapter 5 in Kaas et al., 2008). The stationary-
excess operator (also called equilibrium distribution, see e.g. Chapter 4 in Klugman et al.,
2004) appears in the Beekman formula for the ruin probability in the classical risk theory
model (see e.g. Chapter 8 in Klugman et al., 2004, or Chapter 4 in Kaas et al., 2008).
Several risk measures for an insurance loss X with distribution function FX are based on
the function Z ∞
1
t 7→ E[X|X > t] = xdFX (x).
P[X > t] t
The Conditional Taile Expectation (CTE) is obtained when t corresponds to the Value-
at-Risk (or quantile) of X. Such risk measures are intimately related to the size-biased
transform, as shown next. Consider a (measurable) function g and write
Z ∞
E[Xg(X)] = xg(x)dFX (x)
0
Z ∞
xdFX (x)
= E[X] g(x)
0 E[X]
= E[X]E[g(X)]
e (1.1)

where the non-negative random variable X

e with distribution function
Z t
1
P[X ≤ t] =
e xdFX (x),
E[X] 0

is called the size-biased version of X. In some sense, X

e is larger compared to X, so that X
e
represents a worse loss than X. In order to see why this is true, it suffices to notice that
Xe is distributed as max{X, Z} where the random variable Z is independent of X and has
distribution function
P[Xe ≤ t] E[X|X ≤ t]
P[Z ≤ t] = = .
P[X ≤ t] E[X]
Notice that the size-biased version of any constant c lefts it unchanged, that is, e
c = c. This
shows that no unjustified loading is induced by the size-biased transform.
Now, inserting the function

1 if x > t
g(x) = (1.2)
0 otherwise

in identity (1.1), we see that the representation

P[X
e > t]
E[X|X > t] = E[X] (1.3)
P[X > t]

1
is valid for any threshold t. As X e is larger compared to X, the ratio P[X e > t]/P[X > t]
appearing in (1.3) exceeds unity so that we recover the classical inequality E[X|X > t] ≥
E[X] for all t from elementary probability.
The size-biased transform can be traced back to the late 1960s in the statistical literature.
It has proven to be useful in the study of risk measures after the pioneering work by Furman
and Landsman (2005, 2008a) and Furman and Zitikis (2008a,b) in connection to (1.3).
The size-biased transform is an example of weighted distribution. Initially developed
in order to unify various sampling distributions when the chance of being recorded by an
observer varies, weighted distributions are closely related to weighted risk measures and
weighted capital allocation rules. See Furman and Zitikis (2009). Among these weighted dis-
tributions, the size-biased, or length-biased one corresponds to the identity weight function.
It refers to the situation where larger observations are more likely to be recorded. Hence,
the available data are of bigger size compared to the actual population values. Translated
to an actuarial context, this means that claim amounts are made larger before performing
actuarial calculations, which generates a safety loading.
Let us now turn to a collection of P
n independent insurance losses, denoted as X1 , X2 , . . . , Xn .
Define the aggregate loss S as S = ni=1 Xi . Clearly,
n
X
E[S|S > t] = E[Xi |S > t]
i=1

so that the total E[S|S > t] can be decomposed into the sum of individual contributions
E[Xi |S > t] that are useful in risk management. It is known from Furman and Landsman
(2005) that the representation

P[S − Xi + X
ei > t]
E[Xi |S > t] = E[Xi ] (1.4)
P[S > t]
holds true. In words, the contribution E[Xi |S > t] of risk Xi to E[S|S > t] is equal to its a
priori expectation E[Xi ] increased by the ratio of the excess probabilities P[S − Xi + X
ei > t]
and P[S > t], where X
S − Xi + Xei = Xj + Xei
j6=i

is the sum of all risks Xj , except the ith one which is replaced with its size-biased version
Xei . Hence, S − Xi + X ei tends to be larger compared to S.
Identities (1.3)-(1.4) have been exploited in a number of papers (including those cited
above) to derive many useful properties for risk measures, mainly for continuous losses. In
this paper, we study the case of compound sums that are particularly useful in insurance
applications. When the number of terms is valued in {0, 1}, we find the zero-augmented
distributions which naturally arise in the individual model of risk theory. Particular attention
is paid to compound Poisson sums and compound Negative Binomial sums to which Panjer
recursive formulas apply.
Notice that some particular cases of compound Poisson sums have been considered pre-
viously in the literature. Risk measures for Tweedie distributions have been discussed by
Furman and Landsman (2008b, 2010). Recall that Tweedie distributions include compound

2
Poisson sums with Gamma-distributed claim severities. In this paper, we do not restrict our
analysis to Gamma distributed severities but also consider compound Poisson distributions
with arbitrary claim severity distribution, as well as compound distributions where the num-
ber of terms does not obey the Poisson distribution. An extension to the case of conditional
independence is also considered. The present paper complements the results obtained by
Cossette et al. (2012) and Kim et al. (2019) who favored a computational approach to the
problem.
The remainder of this paper is organized as follows. In Section 2, we recall the main prop-
erties of the size-biased transform. Section 3 derives the size-biased transform of compound
sums. Section 4 is devoted to the compound Poisson case whereas Section 5 discusses the
compound mixed Poisson sums. An extension to conditionally independent random variables
is worked out in Section 6. The final Section 7 briefly concludes the paper.
Throughout this paper, we provide elementary proofs of the results. Some of them are
available in the literature (and the text refers to the published works if this is the case), but
we believe that the simple derivations offered here are both illuminating and easier to follow
for an actuarial readership. In addition to making this paper self-contained, the approach
adopted here helps actuaries to gain a better understanding of the topic. In particular,
some formulas make explicit the loadings corresponding to each source of randomness. This
decomposition appears to be useful for risk management.

2 Size-biased transform
2.1 Definition
2.1.1 General case
Consider a risk X (i.e. a non-negative random variable representing a monetary loss) with
distribution function FX . A size-biased version of X is any risk X
e with distribution function
     Z t
e ≤ t] = E XI[X ≤ t] E X X ≤ t 1
P[X = FX (t) = xdFX (x),
E[X] E[X] E[X] 0

where I[·] denotes the indicator function (which is equal to 1 if the event appearing within
brackets is realized, and to 0 otherwise). The operator mapping the distribution function
FX of X to the distribution function FXe of X e is called the size-biased transform.
A detailed account of the properties of the size-biased transform can be found in Brown
(2006) and Arratia et al. (2019). Most parametric models used in actuarial applications are
closed under size-biasing, provided the parameters are updated accordingly. See e.g. Table
1 in Patil and Rao (1978).

2.1.2 Continuous case

Consider a claim severity C, that is, a positive random variable C corresponding to the
amount of benefit paid in relation to some insurance claim. In general, C is assumed to be

3
continuous with a probability density function fC . We then have
Z t
xfC (x)
P[C ≤ t] =
e dx
0 E[C]

so that the probability density function fCe of C

e is given by

xfC (x)
fCe (x) = , x ≥ 0.
E[C]

Brown (2006) explained the relationship of the size-biased transform of a continuous distri-
bution with the waiting time paradox and provided several applications.

2.1.3 Discrete case

Integer-valued random variables are often considered in actuarial applications to model claim
frequencies or after discretization of the claim severities to perform computations. Given a
counting random variable N valued in {0, 1, 2, . . .} with probability mass function pN , the
probability mass function pNe of the size-biased version N e is obtained as follows:

pNe (k) = P[Ne ≤ n] − P[Ne ≤ n − 1]

 
E N I[N = k] kpN (k)
= = , k = 0, 1, 2, . . .
E[N ] E[N ]

Ross (2003) discussed the relationship of the discrete size-biased transform to the inspection
paradox. Notice that even if pN (0) > 0, we have

pNe (0) = 0 ⇔ N
e ≥ 1 with probability 1. (2.1)

2.2 Risk measurement based on size-biased transform

It is easy to see that X
e is stochastically larger compared to X. Indeed, the random variables
X and I[X ≤ t] are negatively correlated so that
     
e ≤ t] = E XI[X ≤ t] E X E I[X ≤ t]
P[X ≤ = P[X ≤ t]
E[X] E[X]

whatever the threshold t. This inequality shows that the probability that X falls below t
is larger compared to the corresponding probability for its size-biased version X.
e Hence,
replacing the actual loss X with its size-biased transform X can be seen as a safe strategy.
e
In fact, the stronger likelihood ratio order holds. We refer the reader to Denuit et al.
(2005, Chapter 3) for more details concerning this stochastic order relation expressing the
idea of “being larger than” for random variables. In the continuous case investigated in
Subsection 2.1.2, the ratio
fCe (x) x
=
fC (x) E[C]

4
clearly increases in x. In this case, C is said to be smaller than Ce in the likelihood ratio
order. Intuitively speaking, this means that the larger the outcome x, the more likely it
corresponds to a realization of C
e and not of C. A similar interpretation holds in the discrete
case considered in Subsection 2.1.3. Specifically, for a counting random variable N with
probability mass function pN , the ratio of the probability mass functions

pNe (k) k
=
pN (k) E[N ]

clearly increases in k, so that N is smaller than N

e in the likelihood ratio order.
In general, the size-biased version X
e of X is larger than X in the likelihood ratio order
−1


because p 7→ FXe FX (p) is convex (see Proposition 3.3.50 in Denuit et al., 2005). This can
be seen from the identity

E XI X ≤ FX−1 (p)
  
−1
FXe FX (p) =
E[X]

which shows that p 7→ FXe FX−1 (p) is the Lorenz curve of X, which is known to be increasing

and convex. The relationship between the size-biased transform and the Lorenz curve has
been pointed out by Bartoszewicz and Skolimowska (2006, Section 2.1), after Jain et al.
(1989).

2.3 Infinitely divisible case

Assume that X is infinitely divisible. This means that for any positive integer n, X can
be represented as the sum of n independent and identically distributed random variables.
Infinitely divisible distributions on the half positive real line correspond either to compound
Poisson sums if there is a positive probability mass at the origin, or to weak limits of
compound Poisson sums. We refer the reader to Theorems 3.2-3.3 in Steutel and van Harn
(2003, Chapter 3). The Poisson distribution, the Negative Binomial distribution, the Gamma
distribution and the degenerate distribution are examples of infinitely divisible distributions.
The uniform distribution and the Binomial distribution are not infinitely divisible, nor are
any other distributions with bounded (finite) support.
Pakes et al. (1996, Theorem 2.1) established that the size-biased transform of a random
variable X obeying an infinitely divisible distribution can be written as the sum of the initial
random variable plus a non-negative, independent one. Precisely, the following distributional
equality
Xe =d X + ∆ for some random variable ∆ ≥ 0, independent of X. (2.2)
is valid if, and only if the distribution of X is infinitely divisible. We refer the reader to
Arratia and Goldstein (2010) for a detailed analysis of various situations where (2.2) is
valid. The distributional equality (2.2) shows that X e is indeed larger than X, because it
corresponds to X increased by ∆ in the infinitely divisible case.

5
3 Size-biased transform of compound sums
Aggregate losses are often represented by means of compound sums in insurance studies. In
this section, we consider the size-biased transform of such random variables. Compound sums
can be considered as mixtures of sums with a fixed number of terms, letting this number of
terms become random. This is why we start with a couple of results of independent interest,
dealing with size-biased versions of sums and mixtures.

3.1 Size-biased transform of a sum

The following result can be found in Brown (2006, Example 2) or Arratia et al. (2019,
Section 2.4). We provide here an elementary proof of it, for convenience and because it helps
to understand how risk measurement proceeds.
Property 3.1. Consider independent risks X1 , . . . , Xn and let X e1 , . . . , X
en be their corre-
sponding P size-biased versions, assumed to be independent, and independent of X1 , . . . , Xn .
Let S = ni=1 Xi be the sum of the risks X1 , . . . , Xn . Define the random variable K valued
in {1, 2, . . . , n}, independent of X1 , . . . , Xn and of X
e1 , . . . , X
en such that

E[Xi ]
P[K = i] = .
E[S]
Then, X
Se =d S − XK + X
eK = Xj + X
eK , (3.1)
j6=K

where “=d ” means “is distributed as”.

Proof. The random vector (X1 , . . . , Xi−1 , X
ei , Xi+1 , . . . , Xn ) has joint distribution function
 
E Xi I[Xi ≤ xi ] Y
(x1 , . . . , xn ) 7→ P[Xj ≤ xj ].
E[Xi ] j6=i

For any measurable function g, we then have

 
Xi
E[g(X1 , . . . , Xi−1 , X
ei , Xi+1 , . . . , Xn )] = E g(X1 , . . . , Xn ) .
E[Xi ]
Let us now consider " #
n
X
g(x1 , . . . , xn ) = I xj ≤ s .
j=1

We then have  
E X i I [S ≤ s]
h i
P S − Xi + X
ei ≤ s = .
E[Xi ]
Summing this equality over i gives
n h i
  X
E SI [S ≤ s] = E[Xi ]P S − Xi + X
ei ≤ s . (3.2)
i=1

6
This can also be rewritten as
  n
E SI [S ≤ s] X E[Xi ] h i
P[S ≤ s] =
e = P S − Xi + Xi ≤ s .
e
E[S] i=1
E[S]

This ends the proof.

Notice that the proof of Property 3.1 also establishes the validity of the fundamental
identity (1.4). Property 3.1 shows that size-biasing a sum of independent risks is equivalent
to selecting at random (according to the discrete distribution assigning probability E[X i]
E[S]
to
index i) one element appearing in the sum and replacing it with its size-biased version. Thus,
the risks Xi with larger means are more likely to be selected.
In case all individual losses Xi share the same distribution, we get the following simpler
result.

Corollary 3.2. Under the conditions of Property 3.1, if X1 , . . . , Xn are identically dis-
tributed then
n−1
X
S =d
e Xi + X
en . (3.3)
i=1

Size-biasing a sum of independent and identically distributed risks Xi thus amounts to

size-biasing one term and to add it to the remaining n − 1 ones that are left unchanged.
Let us now apply these results to risk measurement.

Property 3.3. Under the conditions of Property 3.1,

hP i
P j6=K X j + X
e K > t
E[S|S > t] = E[S] . (3.4)
P[S > t]

If X1 , . . . , Xn are identically distributed as in Corollary 3.2 then

hP i
n−1
P i=1 X i + X
en
E[S|S > t] = E[S] . (3.5)
P[S > t]

Notice that the mixture representation involved in (3.4) is in line with (1.4) as it can be
rewritten as
hP i
X E[Xi ] P
n
j6=i Xj + Xi > t
e
E[S|S > t] = E[S]
i=1
E[S] P[S > t]
n
X
= E[Xi |S > t].
i=1

7
3.2 Size-biased transform of a mixture
Arratia et al. (2019, Lemma 2.6) studied the size-biased transform of mixtures. The next
result summarizes their findings. We provide the reader with an elementary proof, for
convenience and because this result will also be central to the extension to size-biasing
conditionally independent risks.
Property 3.4. Consider a family of non-negative random variables {Xθ , θ ≥ 0} indexed by
a single, non-negative parameter θ. Let Θ be a mixing parameter with distribution function
FΘ . The corresponding mixture XΘ has distribution function
Z ∞
P[XΘ ≤ x] = P[Xθ ≤ x]dFΘ (θ).
0

Then, the size-biased transform of the mixture XΘ corresponds to the mixture of the non-
negative random variables {Xeθ , θ ≥ 0} with mixing parameter Θ? distributed according to

E[Xθ ]
dFΘ? (θ) = dFΘ (θ). (3.6)
E[XΘ ]
Proof. This result can easily be obtained as follows:
Z x
1
P[XΘ ≤ x] =
f tdFXΘ (t)
E[XΘ ] 0
Z ∞Z x
1
= tdFXθ (t)dFΘ (θ)
E[XΘ ] 0 0
Z ∞
1
= E[Xθ ]FXeθ (t)dFΘ (θ)
E[XΘ ] 0
Z ∞
= FXeθ (t)dFΘ? (θ).
0

This ends the proof.

Property 3.4 essentially shows that the size-biased version of a mixture corresponds to
some mixture of size-biased versions of the mixed components, the mixing distribution being
given in (3.6).
Let us now provide a couple of applications of the result stated in Property 3.4. First, we
show that size-biasing a product of independent factors amounts to multiply their respective
size-biased versions.
Property 3.5. Consider two independent, positive random variables Z and Θ. Then,

ZΘ
g =d ZeΘ.
e

Proof. Let us first consider a constant Θ, that is, Θ = θ with probability 1. The size-biased
transform of θZ has distribution function
Z t  
1 x h xi t
P[Zθ ≤ t] =
f dP Z ≤ =P Z≤ e
E[Z] 0 θ θ θ

8
so that the distributional equality Zθ
f =d θZe holds true. Now, define Xθ = θZ so that XeΘ
corresponds to ZΘ. Considering Property 3.4, this means that ZΘ is a mixture of Zθ =d θZe
g g f
with mixing parameter Θ? defined in (3.6), which gives here

θE[Z]
dP[Θ? ≤ θ] = dP[Θ ≤ θ] ⇔ Θ? =d Θ.
e
E[Θ]E[Z]

This ends the proof.

The result in Property 3.5 can be traced back to Pakes (1997). If Θ corresponds to the
effect of inflation on the nominal amount Z, we see that the size-biased version of the inflated
payment ΘZ is obtained by multiplying the size-biased versions of the random inflation rate
Θ and of the base payment Z.
Let us now consider an application of Property 3.4 to risk measurement.

Property 3.6. Under the conditions of Property 3.4, we have

R∞
P[Xeθ > t]dFΘ? (θ)
E[XΘ |XΘ > t] = E[XΘ ] R0∞ .
0
P[X θ > t]dF Θ (θ)

Considering the representation in Property 3.6, we see that E[XΘ |XΘ > t] is obtained
by multiplying E[XΘ ] with a ratio of two excess probabilities. In the numerator, we have
eθ , θ ≥ 0} with mixing parameter Θ? exceeds t whereas
the probability that a mixture of {X
in the denominator, the probability that the original mixture {Xθ , θ ≥ 0} with mixing
parameter Θ exceeds the same threshold.

3.3 Size-biased transform of a compound sum

We are now ready to derive the size-biased transform of a compound sum. The next result is
stated without proof in Brown (2006, Section 2.2) as a direct consequence of the properties
of the size-biased transform for sums and mixtures. We provide the reader with a formal
derivation and then consider several particular cases of interest in actuarial risk theory.

Proposition 3.7. Consider the compound sum X = N

P
k=1 Ck where N is valued in {0, 1, 2, . . .}
and the severities C1 , C2 , . . . are identically distributed, distributed as C, all these random
variables being independent. Then,
e −1
N
X
X
e =d C
e+ Ck .
k=1
Pn
Proof. Let µ = E[C]. The compound sum X can be seen as the mixture of Xn = k=1 Ck
with
E[Xn ] = nµ and E[X] = E[N ]µ.
Corollary 3.2 shows that
X
en =d C
e + Xn−1 .

9
By Property 3.4, we know that X en with mixing parameter N ? such that
e is a mixture of X

pN ? (n) n
= ⇒ N ? =d N
e.
pN (n) E[N ]

This ends the proof.

Size-biasing a compound sum thus amounts to size-biasing one term and to add it to
a compound sum where the claim severity distribution is left unchanged but the claim
frequency becomes N e − 1. Remember from (2.1) that N e ≥ 1 with probability one, so that
Ne − 1 is valued in {0, 1, 2, . . .} and thus eligible as a claim frequency. Size-biasing thus
impacts on the claim severity distribution through the replacement of one term with its size-
biased version Ce as well as to claim frequency distribution by replacing N with its size-biased
version Ne shifted by 1.
Comparing the result in Proposition 3.7 to Corollary 3.2, we see that the fixed number of
terms n has been replaced here with N e . As size-biasing a constant leaves it unchanged, the
result stated in Corollary 3.2 can be recovered as a particular case of Proposition 3.7 when
the claim frequency distribution concentrates all its probability on a single value n.
The following result considers the particular case where the claim severities involved in
the compound sum obey an infinitely divisible distribution. If C is infinitely divisible then
we know from (2.2) that there exists a positive random variable ∆, independent of C such
that Ce =d C + ∆. This allows us to rewrite C e + PNe −1 Ck in Proposition 3.7 as ∆ + PNe Ck ,
k=1 k=1
as formally stated next.

Corollary 3.8. If C is infinitely divisible then the compound sum X in Proposition 3.7 has
size-biased transform
XN
e

X
e =d ∆ + Ck
k=1

where ∆ is the random, independent addition involved in the distributional equality C

e =d
C + ∆, all the random variables being independent.

When claim severities are infinitely divisible, an extra term can be included in the sum
of the severities Ck which now runs to N e.
Let us now apply these results to risk measurement.

Property 3.9. Under the conditions of Proposition 3.7,

h i
P C e + PNe −1 Ck > t
k=1
E[X|X > t] = E[X] .
P[X > t]

Under the conditions of Corollary 3.8,

h PNe i
P ∆ + k=1 Ck > t
e
E[X|X > t] = E[X] .
P[X > t]

10
 Replacing N with the constant n, we find the result stated for identically distributed
summands in Property 3.3 as a particular case.
Now that general expressions have been obtained for the size-biased version of compound
sums, we are ready to study the compound Poisson and compound mixed Poisson sums that
are particularly useful in insurance studies. This is the topic of the next two sections.

4 Compound Poisson case

4.1 Size-biased transform of compound Poisson sums
Compound Poisson sums are particular cases of the compound sums considered in Proposi-
tion 3.7 where N is Poisson distributed. They have infinitely divisible distributions so that
(2.2) applies. The next result identifies the random variable ∆ appearing in this distribu-
tional equality, which turns out to correspond to the size-biased transform of the generic
term C.
PN
Property 4.1. Consider X = k=1 Ck as described in Proposition 3.7 with N Poisson
distributed with mean λ, which is henceforth denoted as N ∼ Poi(λ). Then,

X
e =d X + C.
e

Proof. The Poisson distribution can be characterized as follows (Arratia et al., 2019, Propo-
sition 2.1):
N ∼ Poi(λ) ⇔ N e =d N + 1.

This is easily seen as follows. If N ∼ Poi(λ) then pNe (0) = 0 and for k ≥ 1,
k
k exp(−λ) λk!
pNe (k) =
λ
λk−1
= exp(−λ)
(k − 1)!

so that N
e =d N + 1. The announced result then follows from Proposition 3.7.

Size-biasing a compound Poisson sum thus amounts to supplement it with the size-biased
version of its generic term. As every compound Poisson sum is infinitely divisible, Property
4.1 identifies the random variable ∆ involved in (2.2) which corresponds to C.
e

Remark 4.2. In the discrete case, when the random variables Ck are valued in {1, 2, 3, . . .},
the result stated in Property 4.1 directly follows from Panjer recursion formula
k
λX
P[X = k] = jP[C = j]P[X = k − j]
k j=1

11
starting from P[X = 0] = exp(−λ). Indeed, it suffices to multiply both sides of this recursion
formula with k/E[X] = k/(λE[C]) to get
k
X jP[C = j]
P[X
e = k] = P[X = k − j]
j=1
E[C]
k
X
= e = j]P[X = k − j]
P[C
j=1

= P[X + C
e = k],

which is exactly the result in Property 4.1. Compound Poisson distributions with discrete
summands have been extensively considered in Arratia and Goldstein (2010, see formula
(22) in that paper) using the standard representation of compound Poisson distributions
with discretely distributed summands given e.g. in Theorem 3.4.2 in Kaas et al. (2008),
often used in actuarial risk theory. Property 4.1 extends these results to the general case,
with arbitrary claim severities.

Let us now consider the particular case where claim severities are infinitely divisible.

Property 4.3. If C is infinitely divisible then the compound sum X in Property 4.1 has
size-biased version
N
X +1
X =d ∆ +
e Ck
k=1

where ∆ is the random addition involved in the distributional equality C

e =d C + ∆, all the
random variables being independent.

4.2 Application to risk measurement

Let us now apply the results obtained for the size-biased transform of compound Poisson
sums to risk measurement.

Property 4.4. Under the conditions of Property 4.1,

P[X + C
e > t] E[X]
E[X|X > t] = E[X] = .
P[X > t] P[X > t|X + C
e > t]

When the claim severity distribution is infinitely divisible,

P[X + C + ∆ > t] E[X]

E[X|X > t] = E[X] = .
P[X > t] P[X > t|X + C + ∆ > t]

Let us now consider independent losses X1 , . . . , Xn where each Xi is compound Poisson,

that is,
XNi
Xi = Cik
k=1

12
where Ni ∼ Poi(λi ) and the claim severities Cik are positive, continuous, and distributed
Pn as
Ci , all these random variables being independent. Consider the total amount S = i=1 Xi .
According to Property 3.1, we have

eK with P[K = i] = Pnλi E[Ci ] .

Se =d S − XK + X
j=1 λj E[Cj ]

Property 4.1 shows that the distributional equalities

X
ei =d Xi + C
ei hold for all i so that X
eK =d XK + C
eK

also holds true. Hence,

S − XK + X
eK =d S + C
eK

so that we finally obtain

P[S + C
eK > t]
E[S|S > t] = E[S]
P[S > t]
with n
ei > t] Pnλi E[Ci ] .
X
P[S + C
eK > t] = P[S + C (4.1)
i=1 j=1 λj E[Cj ]

Equivalently,
n
X P[S + C
ei > t]
E[S|S > t] = λi E[Ci ] .
i=1
P[S > t]
Also, since
S − Xi + X
ei =d S + C
ei

we get from (1.4)

P[S + Cei > t]

E[Xi |S > t] = E[Xi ]
P[S > t]
E[Xi ]
= .
P[S > t|S + Cei > t]

The aforementioned results can also be obtained as follows. Because S is a sum of

independent
PM compound Poisson sums, it isP
itself a compound Poisson sum. Precisely, S =d
n
k=1 Zk with M ∼ Poi(λ• ) where λ• = i=1 λi and Z1 , Z2 , . . . are independent random
variables distributed as Z with
n
X λi
P[Z ≤ t] = P[Ci ≤ t],
λ
i=1 •

all the random variables being independent. This can be equivalently stated as Z =d CJ
with P[J = i] = λλ•i . Hence, we can apply Property 4.1 directly to S to get

Se =d S + Z.
e

13
We know from Property 3.4 that Ze obeys a mixture of C
e1 , . . . , C
en with mixing distribution

E[Ci ]
P[J ? = i] = P[J = i]
E[CJ ]
λi E[Ci ]
= Pn
j=1 λj E[Cj ]
= P[K = i].

We thus see that Ze =d CeK and we also recover (4.1) proceeding in this way.
The formulas derived in this section provide the actuary with an effective algorithm to
compute E[Xi |S > s]. Assume for simplicity that the claim severities Cik are integer-valued
(if needed, they can be discretized prior to calculations). Then, S is also compound Pois-
son distributed and integer-valued. Its distribution can be obtained from Panjer recursion
recalled in Remark 4.2. Precisely,
k n
1X X
P[S = k] = j λi P[Ci = j]P[S = k − j].
k j=1 i=1

The distribution of S + C ei can then be obtained by convolution and the desired value is
obtained by multiplying E[Xi ] with the ration P[S + C ei > s]/P[S > s].
Taking for s the Value-at-Risk, or quantile at level p of S, the contribution of Xi to the
conditional tail expectation of S at probability level p is given by

E[Xi ]
E[Xi |S > FS−1 (p)] = −1
ei > F −1 (p)].
P[S + C S
P[S > FS (p)]

In the continuous case, we simply have P[S > FS−1 (p)] = 1 − p. Now, if the claim sizes are
homogeneous, that is, Ci =d Cj for all i, j then

ei > F −1 (p)] = P[S + C

P[S + C ej > F −1 (p)]
S S

and
E[Xi |S > FS−1 (p)] λi
−1 = .
E[Xj |S > FS (p)] λj
As n
X
E[Xi |S > FS−1 (p)] = E[S|S > FS−1 (p)]
i=1

is the conditional tail expectation of S, we finally get

λi
E[Xi |S > FS−1 (p)] = E[S|S > FS−1 (p)].
λ•
This provides the actuary with a simple formula to distribute the total conditional tail
expectation of S, based on the ratios λλ•i of expected claim frequencies.

14
5 Compound mixed Poisson case
5.1 General Poisson mixtures
In this section, we replace the Poisson mean λ with a positive random variable Λ. This
construction corresponds to a mixed Poisson distribution with mixing parameter Λ and
the corresponding compound sum is a mixed Poisson one. Henceforth, we use subscripts
“Λ” or “λ” to indicate whether we work with the mixture NΛ or Nλ given Λ = λ, or the
corresponding compound sums XΛ or Xλ .
Property 5.1. Consider XΛ = N
P
k=1 Ck as described in Proposition 3.7 with N obeying the
Poi(Λ) distribution given Λ. Then,

X
eΛ =d X e + C.
Λ
e

Proof. Let us apply Property 3.4 with

Nλ
X
Xλ = Ck
k=1

where Nλ ∼ Poi(λ) and the Ck are distributed as C, all these random variables being
independent. Then, invoking Property 4.1, X
e appears to be a mixture of

X
eλ =d Xλ + C
e

with mixing
dFΛ? (λ) λ
= ⇒ Λ? =d Λ.
e
dFΛ (λ) E[Λ]
This ends the proof as the distribution of C
e does not involve the mixing parameter.

Compared to Property 4.1 applying to homogeneous Poisson claim frequencies, we see

that X is replaced with XΛe so that the mixing parameter Λ is replaced with its size-biased
version Λe in the mixed Poisson claim frequency distribution. As we know that size-biasing a
constant leaves it unchanged, Property 4.1 can thus be seen as a particular case of Property
5.1.
Coming back to the Poisson process setting, it is often assumed that the mixing distribu-
tion involved in a general Poisson mixture is infinitely divisible. This ensures the coherence
between the sum of counts recorded over disjoint time intervals and the corresponding to-
tal recorded over the entire observation period (i.e., the union of these intervals). If Λ is
infinitely divisible then we know from (2.2) that the distributional equality
e =d Λ + E
Λ

holds true for some positive random variable E, independent of Λ. Since the Poisson distri-
bution is stable by convolution, we know that

NΛ+E =d NΛ + NE ,

15
all the random variables being independent. In the setting of Property 5.1, we then have
X
eΛ =d XΛ+E + C
e
=d XΛ + XE + C,
e (5.1)
all the random variables being independent. Identity (5.1) shows that size biasing a com-
pound mixed Poisson sum XΛ corresponds to the sum XΛ itself (as in the homogeneous
Poisson case) plus a compound mixed Poisson sum XE corresponds to the size-biasing of the
mixing parameter to which the size-biased version Ce of the generic claim severity is added.
Thus, XE can be considered as an extra loading, compared to the compound Poisson case.
Let us now apply these results to risk measurement.
Property 5.2. Under the conditions of Property 5.1,
P[XΛe + C
e > t]
E[XΛ |XΛ > t] = E[XΛ ] .
P[XΛ > t]
If the mixing distribution is infinitely divisible then
P[XΛ + XE + C
e > t]
E[XΛ |XΛ > t] = E[XΛ ]
P[XΛ > t]
where E is the positive random variable involved in the distributional equality Λ
e =d Λ + E
known to be valid from (2.2), all the random variables being independent.

5.2 Negative Binomial case

Assume that the Poisson parameter λ is replaced with a random variable Λ obeying the
Gamma distribution with mean α/β and variance α/β 2 , which is henceforth denoted as
Λ ∼ Gam(α, β). Then, the counting distribution is the Negative Binomial N Bin(α, β) with
probability mass function
βα Γ(α + k)
P[N = k] = α+k
, k = 0, 1, 2, . . .
(1 + β) k!Γ(α)
Property 5.3. Consider X = N
P
k=1 Ck as described in Property 5.1 with Λ ∼ Gam(α, β) so
that N obeys the N Bin(α, β) distribution. Then,
X
eΛ =d C
e + XΛ + X E

where E ∼ Gam(1, β), all the random variables being independent.

Proof. The probability density function of Λ? obtained from Λ with the transform (3.6) is
given by
λ
fΛ? (λ) = fΛ (λ)
α/β
λ λα−1 β α exp(−λβ)
=
α/β Γ(α)
α α+1
λ β exp(−λβ)
=
Γ(α + 1)

16
so that
Λ? =d Λ
e ∼ Gam(α + 1, β).

Hence, Λ? =d Λ+E with E ∼ Gam(1, β) and the announced result then follows from (5.1).
Define N ? as the mixed Poisson distribution, with mixing parameter Λ? . Then, N ? ∼
N Bin(α + 1, β). Now, the size-biased transform of the N Bin(α, β) distribution has proba-
bility mass function

kP[N = k] β α+1 Γ(α + k)

P[N
e = k] = = α+k
α/β (1 + β) (k − 1)!Γ(α + 1)

so that Ne − 1 =d N Bin(α + 1, β). Hence, N ? is distributed as N e − 1 and we recover a

particular case of the general result contained in Proposition 3.7.

5.3 Application to risk measurement

Let us now consider independent losses X1 , . . . , Xn where each Xi is compound mixed Pois-
son, that is,
XNi
Xi = Cik
k=1

where Ni ∼ Poi(λ) given Λi = λ and the claim severities Cik are positive, continuous, and
distributed as Ci , all these random variables being independent. Consider the total amount
S = ni=1 Xi .
P
In the compound mixed Poisson case, the distributional equality
X
S − Xi + X
ei =d Xj + XΛe i + C
ei
j6=i

holds true for i = 1, 2, . . . , n. Assume furthermore that Λi is infinitely divisible. Then,

e i =d Λi + Ei and the distributional equality (5.1) allows us to write
Λ

S − Xi + X
ei =d S + XE + C
i
ei .

Hence, we finally get

P[S + XEi + C
ei > s]
E[Xi |S > s] = E[Xi ] .
P[S > s]

Comparing this expression to the compound Poisson case, we see that the extra-randomness
in the Poisson parameter induces an additional term XEi appearing in the excess probability
in the numerator.

17
6 Extension to conditionally independent risks
6.1 Correlated risks
Let us now turn to a collection of n insurance losses, denoted as X1 , X2 , . . . , Xn , possibly
correlated. Hence, we consider the random vector, or insurance portfolio X = (X1 ,P . . . , Xn )
with joint distribution function FX . As before, define the aggregate loss S as S = ni=1 Xi .
Following the same lines as in Section 1, we can write
Z ∞ Z ∞
E[Xi g(S)] = ··· xi g(x1 + . . . + xn )dFX (x1 , . . . , xn )
0 0
Z ∞ Z ∞
xi dFX (x1 , . . . , xn )
= E[Xi ] ··· g(x1 + . . . + xn )
0 0 E[Xi ]
= E[Xi ]E[g(Y1 + . . . + Yn )]

where the joint distribution function FY of the random vector Y = (Y1 , . . . , Yn ) is given by
Z y1 Z yn
xi dFX (x1 , . . . , xn )
FY (y1 , . . . , yn ) = ··· . (6.1)
0 0 E[Xi ]

We thus see that Yi is distributed as Xei , marginally. For j 6= i, the marginal distribution of
Yj is now given by
Z yj Z ∞
xi dF(Xi ,Xj ) (xi , xj ) E[Xi |Xj ≤ yj ]
P[Yj ≤ yj ] = = P[Xj ≤ yj ]. (6.2)
0 0 E[Xi ] E[Xi ]

Interestingly, some positive dependence is needed among the components of X to ensure

that the random vector Y is larger compared to X. We refer the reader to Cohen and
Sackrowitz (1995) for various conditions (the weakest one being referred to as association;
see e.g. Denuit et al., 2005, Chapter 7, and Property 6.1 below). To see why this is actually
needed, assume that the individual risks X1 , . . . , Xn are negatively related. Precisely, assume
that Xi is negatively expectation dependent on Xj , that is, the inequality

E[Xi |Xj ≤ yj ] ≥ E[Xi ]

holds true for all yj . In words, this means that the knowledge that Xj is small, that is,
Xj falls below the threshold yj , makes Xi larger on average. We then see from (6.2) that
the inequality P[Yj ≤ yj ] ≥ P[Xj ≤ yj ] is valid for all yj , so that Yj is smaller than Xj in
first-order stochastic dominance: the probability that Yj falls below any threshold yj is larger
than the corresponding probability for Xj . Switching from X to Y is thus not necessarily
a conservative strategy in this case. To prevent such a phenomenon to occur, some positive
dependence is needed among X1 , X2 , . . . , Xn .
We also see that
E[Xi |X1 ≤ y1 , . . . , Xn ≤ yn ]
FY (y1 , . . . , yn ) = FX (y1 , . . . , yn ).
E[Xi ]

18
Hence, to ensure that FX dominates FY , so that Y is larger than X (in the sense of the
lower orthant order, that is, the joint distribution function FX dominates FY everywhere),
the inequality
E[Xi |X1 ≤ y1 , . . . , Xn ≤ yn ] ≤ E[Xi ]
has to be valid for all y1 , . . . , yn . This condition expresses some positive relationship between
the individual risks X1 , . . . , Xn . It appears to be similar to the one imposed by Guo et al.
(2016); see also Denuit and Mesfioui (2017).
Considering independent losses X1 , . . . , Xn , we see that Y1 , . . . , Yn are also independent
random variables. Furthermore, Yj is distributed as Xj for j 6= i whereas Yi is distributed
as Xei .
In the remainder of this section, we consider conditionally independent risks. This con-
struction is widely used in actuarial models and allows us to derive extensions of the results
obtained earlier in this paper.

6.2 Common mixture model

The common mixture model (in the terminology of Wang, 1998) consists in conditionally
independent risks and forms the basis of the credibility approach. The kind of dependence
induced by this construction is comprehensively studied in Denuit et al. (2005, Chapter
7). The intuition behind this modeling approach is as follows: an external mechanism,
described by the positive random variable Λ, influences several risks X1 , X2 , . . . , Xn . Given
the environmental parameter Λ, the individual risks are independent. Formally, the joint
distribution function of the portfolio vector X can be written as
 
FX (t1 , . . . , tn ) = E P[X1 ≤ t1 , . . . , Xn ≤ tn |Λ]
Z ∞ Y n
!
= P[Xi ≤ ti |Λ = λ] dFΛ (λ). (6.3)
0 i=1

Notice that this construction is rather general and covers for instance the case of the common
shock model, where each risk Xi is obtained as the sum of two independent random variables,
where the second one is common to all risks. This common shock then plays the role of Λ in
the common mixture model. More examples are considered in the remainder of this section.
It is reasonable to expect that the risks Xi resulting from this construction are positively
correlated provided they all move in the same direction with Λ. This makes the random
vector Y with distribution function (6.1) larger so that size-biasing induces a safety margin
in this case. This is formally stated in the next result, of which we provide the reader with
an elementary proof borrowed from Shaked and Shanthikumar (2007, Theorem 6.B.8).
Property 6.1. Consider the risks X1 , X2 , . . . , Xn with join distribution function (6.3). As-
sume that all the risks Xi become larger when Λ increases, in the sense of first-order stochastic
dominance, that is,
P[Xi ≤ t|Λ = λ] ≥ P[Xi ≤ t|Λ = λ + δ] for all t, λ > 0, δ > 0, and i = 1, 2, . . . , n.
Then, the random vector Y with distribution function (6.1) is larger than X in the sense
of multivariate first-order stochastic dominance, that is, the inequality E[g(X)] ≤ E[g(Y )]
holds true for every non-decreasing function g such that the expectations exist.

19
Proof. We know from Property 7.2.16 in Denuit et al. (2005) that the risks X1 , . . . , Xn are
associated random variables, that is, the covariance C[g1 (X)], g2 (Y )] is non-negative for all
non-decreasing functions g1 and g2 . Now, considering a non-decreasing function g,
Z ∞ Z ∞
E[g(Y )] = ··· g(y)dFY (y)
0 0
Z ∞ Z ∞
dFY (y)
= ··· g(y) dFX (y)
0 0 dFX (y)
Z ∞ Z ∞ Z ∞ Z ∞
dFY (y)
≥ ··· g(y)dFX (y) ··· dFX (y)
0 0 0 0 dFX (y)
= E[g(X)]

where the inequality comes from the covariance inequality defining association and the non-
decreasingness of the ratio dFY (y)/dFX (y).
A typical situation where the common mixture construction applies is as follows. Assume
that claim amounts are subject to inflation so that Xi = Zi Λ where Zi is the nominal claim
amount and Λ models the impact of inflation. The random variables Z1 , . . . , Zn , Λ are
assumed to be independent. Clearly, the risks Xi are positively related so that size-biasing
indeed induces the necessary safety loading. Then,

n
X n
^
X
S=Λ Zi and Se =d Λ
e Zi
i=1 i=1

invoking Property 3.5. Hence,

n
!
X
Se =d Λ
e Zi − ZK + ZeK
i=1

where the random variable K is defined as in Property 3.1, that is,

E[Xi ] E[Zi ]
P[K = i] = = Pn .
E[S] j=1 E[Zj ]

6.3 Conditionally independent compound mixed Poisson sums

Let us now assume that given Λ = λ each Xi is a compound Poisson sum with Ni ∼ Poi(ai λ).
Claim severities remain independent but the random vector of claim frequencies (N1 , . . . , Nn )
now obeys the common mixture model. In this case, all components Xi increase in Λ in the
first-order stochastic dominance (see Chapter 7 in Denuit et al., 2005). This construction is
a particular case of the model considered in Kim et al. (2019). The following result gives
the size-biased version of S in this case.

Property 6.2. Assume that Xi = N

P i
k=1 Cik where the claim severities Cik are positive, con-
tinuous, and distributed as Ci , all these random variables being independent, i = 1, 2, . . . , n,

20
and independent of (N1 , . . . , Nn ). Each Ni obeys the Poi(ai Λ) distribution given Λ, for some
positive constants a1 , . . . , an . Then,

Se =d SΛe + C
eK

where the random variable K is valued in {1, . . . , n} with

ai E[Ci ]
P[K = i] = Pn , i = 1, . . . , n.
j=1 aj E[Cj ]

Proof. Here,PS appears to be a mixture of Sλ where Sλ =d M

P
k=1 Zk , with M ∼ Poi(a• λ)
n
where a• = i=1 ai and Z1 , Z2 , Z3 , . . . are independent and distributed as Z with distribution
function n
X ai
P[Z ≤ t] = P[Ci ≤ t].
i=1
a •

ai
All the random variables involved in Sλ are independent. Thus, Z =d CJ with P[J = i] = a•
.
We know from Property 4.1 that
Seλ =d Sλ + Z.
e

Property 3.4 shows that Ze obeys a mixture of C

e1 , . . . , C
en with mixing distribution

E[Ci ]
P[J ? = i] = P[J = i]
E[CJ ]
ai E[Ci ]
= Pn .
j=1 aj E[Cj ]

Hence, Ze =d CK and the distribution of Ze does not involve Λ. Now, the size-biased transform
of S is a mixture of the size-biased versions Seλ , with mixing distribution

E[Sλ ]
dP[Λ? ≤ λ] = dP[Λ ≤ λ]
E[S]
λ
= dP[Λ ≤ λ]
E[Λ]

so that Λ? =d Λ. This ends the proof.

Notice that S in Property 6.2 is a compound Poisson sum so that the announced result
can also be obtained as a direct consequence of Property 5.1. The results derived in this
section remain nevertheless useful to derive the individual contributions E[Xi |S > t] of the
conditionally independent compound mixed Poisson sums Xi .

7 Discussion
This paper offers a systematic treatment of the size-biased transform of compound distri-
butions that are particularly relevant for actuarial applications. We consider the cases of

21
independence and conditional independence, given a common risk factor. The results estab-
lished in this paper are applied to risk measures derived from the size-biased transform, like
the conditional tail expectation.
The formulas established in this paper provide actuaries with effective ways to compute
risk measures, mainly based on Panjer recursive formulas in the compound Poisson and
Negative Binomial cases. Besides they also allow for a deeper understanding of the way risk
measurement proceeds as extra randomness is reflected in additional terms involved in the
size-biased version of the initial risk. For instance, switching from a compound homogeneous
Poisson sum to a compound mixed Poisson sum is reflected into an additional term involving
the size-biased version of the mixing parameter.

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